Asian markets got off to an only mildly down start, so I busied myself on a post that took some concentration, along with some nagging tech matters. As I’m about to turn in, it appears that Asian markets decayed during the trading day and Europe is off to a wobbly start.
The Nikkei finished down over 2.6%. The Japanese index has become so volatile that that means less than it once did but the Hang Seng also closed down over 2.2%. Gold has retreated to 1358. The FTSE is now down over .7%, the Dax is off 1 1.38%. (As I am wrapping up the post, Europe has regrouped a bit, with the FTSE down a mere .45% and the Dax lower by a mere .94%)
The trigger, of course, has been the rapid retreat of hot money from emerging markets. In a nervous-making echo of the 1998 Asian crisis, key Eastern currencies are plunging. From Bloomberg:
Indian 10-year bond yields rose to the highest level since 2001 while the rupiah fell 2.5 percent and the rupee dropped 0.8 percent…India’s rupee is at a record low, Thailand is in recession and Indonesia’s widest current-account deficit pushed the rupiah to the weakest level since 2009.
Oh, and let us not forget that the rumblings of worry about China have also gotten a bit louder of late.
The trigger, natch, is the prospect of the Fed’s taper. The US monetary authority firmly rejected complaints of emerging markets central bankers during QE that the Fed’s actions were generating inflation and unwelcome currency speculation. The market action now looks like a solid vindication of their argument.
Commodities markets have softened too, with the GCSI off 0.9%, also confirming the widely-held belief of the influence of financial markets operators on commodity prices (witness the suddenly aggressive stance of US regulators against the participation of major dealers like Goldman and JP Morgan in warehousing and products that allow for accumulation of physical stockpiles).
US Treasuries have continued to grind downward, with ten-year yields hitting 2.88% yesterday before retreating a smidge. Perhaps even worse for the Fed, after a some weakening in economic reports (more consumer deleveraging, a marked fall in consumer confidence, housing starts missing forecasts), mortgage rates continue to rise, with Bloomberg showing 30-year rates at 4.59%, not far below recent highs of 4.64% (they had backed off to below 4.30% for a few weeks based on Fed officials expressing particularly solicitude about not wanting to undermine the housing recovery).
But there is a bit of good news in all the gloom. At least one analyst blames the swoon on Larry Summers! Will the market hissy fit dent his candidacy? From Clusterstock:
Nomura’s George Goncalves says the bond weakness has to do with angst surrounding the next Fed chair, and the possibility that Larry Summers will be appointed, and take the Fed in a more hawkish direction, meaning fewer asset purchases, and a faster move away from zero interest rates.
Thin summer volumes, bull trap head-fake and slightly better data exposed UST market weakness; it’s no longer just fear of tapering but also uncertainty regarding the next Fed Chair
This past week the US rates market displayed unusual behavior as it didn’t require much in order for bonds to get crushed. We wait anxiously for the FOMC minutes and other key Fed events ahead to gauge what lies ahead for USTs. The biggest risk to the bond market and our tactical bullish trades in our model portfolio is the combination of tapering fears and the election of a more hawkish Chairperson. In such a scenario we wouldn’t be surprised that investors just sit on the sidelines and see how high rates can go if a hawkish Fed nominee is announced, with an overshoot meaningfully above 3% possible. At such extreme levels, we believe that stocks would be under even more pressure as bonds become competitive again and asset allocation adjustments eventually reverse the flows back into bonds.
While our survey and many economists’ and market participants’ predications are that Yellen is still the favorite, there is real possibility about Summers as a real possibility. The risk is that the people who are calling for Yellen could be wishful thinking as market participants may be addicted to the easy money policies of the Fed. These market participants may not view Yellen as the non-disruptive change agent but instead as dove that is similar to (or in some ways even more dovish than) Bernanke. Some media outlets (most noticeably CNN) and online probability trading sites are predicting that Summers gets the nomination. In our survey, our hedge fund accounts are also expecting Larry to get the nod.
The idea that Summers is “hawkish” compared to Yellen is probably an oversimplification of the differences between them, but that is the blunt way the two are perceived. And we can corroborate that there was tons of Summers talk this week, especially on Friday after reporter John Harwood said on Twitter that a good source of his placed the odds of Summers getting the nomination at 2/3. At least in the short term, it seems like this debate will be part of the interest rate equation.
It would be deliciously ironic if the guy Wall Street is pumping for is in fact undermining market confidence. Of course, that’s partly a reflection of the corner the Fed has backed itself into, that any QE exit is likely to be far more disruptive than Bernanke wants to believe. When he first took the helm at the Fed, one of my hedge fund buddies, himself a former Fed economist, remarked that the record of academic economists as Fed chairmen was poor. Despite getting good interim grades from the punditocracy, the aftermath of QE may prove that early call on Bernanke to be correct.